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Corruption: Where We Don’t Like Folks Getting Along Too Well | Lalit Panda

Back in 1968, the Swedish economist Gunnar Myrdal noted that corruption was “almost taboo as a research topic” in economics and planning. Susan Rose-Ackerman’s 1975 article on “The Economics of Corruption” (examining competition and corrupt dealings in government contracting processes) is considered a turning point in approaches to the issue and the subject has become a fertile ground for inquiry since. Economics had, of course, previously developed a politically (or economically) correct term to condemn corrupt activity: rent-seeking. However, this is a much wider term, referring even to entirely legal pursuits by which individuals could seek to corner wealth for themselves without actually participating to create new wealth. Corruption is at best a sub-class of such inefficient activity involving individuals using their positions of power or public offices to extract rent (as if their posts were rooms to be let out for rent).

Here, I hoped to point out a couple of approaches to combat corruption by employing lessons from transaction cost economics. Much of transaction cost economics (and economics generally) likes to view agreements and contracts to be great stuff to enhance efficiency and increase welfare in a decentralised manner through the efforts of individuals to satisfy their private preferences. In this line of thought, agreements are viewed as things to be promoted, including by law and governmental policy. It should be no big surprise though that corrupt agreements are not really desirable given the economic inefficiencies they give rise too. Often, the result of corruption is the subversion of some broader governmental objective to build institutions and rules for better resource allocation in combating some market failure. The market rubric doesn’t fit in well with such offices and public institutions and under-the-table dealings are rightly frowned upon.

However, the efforts of economists to promote transactions can be used to formulate potential solutions to corruption. Economists often view “transaction costs” as barriers to more wholesome and widespread economic activity. Such costs can be diverse in variety and need only prevent two or more people from agreeing to transact in some way or the other. It could be because the two potential contracting parties don’t know each other, or don’t know about each other’s goods or preferences, or have doubts regarding the quality of goods on offer, or have doubts regarding whether there will be actual payment at the end of the deal, or are unwilling to spend time bargaining to arrive at satisfactory prices etc. To promote transactions, it should be natural that legal rules should reduce these transaction costs: it should make market information better available through systematic pricing, through wide variety in competition, through the certain enforcement of contracts, through the certain compensation for breaches in contracts etc.

But how if we reverse this logic? What if we don’t want some category of agreements from happening? Can’t we try to increase the transaction costs that need to be incurred to carry out corruption by raising the levels of uncertainty involved or difficulty in bargaining? Here are some general observations on how this already happens or could proceed (with the caveat that no one method is effective alone, of course):

1. The Rule of Law: An age-old technique is the limitation of the discretion of decision-making officials through rules or constraints. These rules could list the reasons for which a particular decision is to be made in a particular manner. Thus, a judge is not meant to decide a matter of theft according to the bribe given to him or her by the thief but instead according to the rules regarding when property rights have been violated. The rule of law often requires elaboration as to the reasons for passing a judgment and such reasons have to adhere to the reasons listed in law. It should be clear that mandatory rules and the obligation to give reasoned judgments eliminate the scope for illicit agreements between judges and rule-violators. A rigorous method of putting in place such mechanisms is to create simple checklists or relevant criteria that must be met before a decision can be made a particular way. This logic is given a general formulation in Joseph Raz’s characterisation of legal rules as “exclusionary reasons”.

2. Whistle-Blowing Incentives: If rules reward people who reveal attempted compromise of official decisions, those who try to compromise these decisions and the relevant officials will think twice before making corrupt agreements because they will be faced with uncertainty regarding whether their corrupt agreement will be carried through or turned against them by the other party. Mistrust of a potential partner can be the end of many a partnership. This is the inverse of the contract-enforcement logic for the promotion of transactions.

3. Public Disclosure and Transparency: Often, it is not possible for any one investigator or authority to figure out whether a particular decision has been made on the basis of a corrupt agreement or on the basis of legitimate reasons. The benefit of transparency or public disclosure is that it reduces the costs of sourcing the relevant information that allows detection of corruption. An ombudsman may not know that a bureaucrat is a friend of a contractor in a bidding process, but the rival of the contractor may know this. Thus, all identities of contenders in the bidding process should be kept public. The increased possibility of detection reduces the certainty of transacting parties that their agreement will go through. Similarly, transparency should extend to information regarding parties and material under consideration. Any inaccuracies can be pointed out. Where the relevant material is complex, one tends to opt for record-keeping and systematic auditing of the relevant records.

4. Leveraging Known Differences in Interests/Preferences: A good way of ensuring that decisions proceed on sound reasoning and not bias or corruption is to ensure that multiple decision-makers with conflicting preferences are placed together or are pitted against each other. This may be seen in the adversarial system of legal adjudication of disputes and also in such proposed legal bodies as the NJAC which sought to pit all sorts of conflicting office-holders like judges, Leaders of Opposition, Law Ministers, civil society members etc. against each other in a (commendable) attempt to achieve fidelity in the appointment of judges. This may generally also be seen in the doctrine of checks and balances in Administrative Law. In economic terms, this effectively involves increasing the bargaining costs for corrupt agreements.

5. Insulation of Decision-Makers from Parties: If the parties who may benefit from a decision know who the decision-maker is, they may try to compromise the decision-maker prior to the decision. It makes sense to keep the identity of the decision-maker secret or in some other way difficult to ascertain. One may see this in the use of double-blind peer-review processes in the assessment of research articles for publication in a journal. Why not have similar mechanisms for various public functions?

6. Randomisation: A nifty mechanism of ensuring that a decision-maker is not sold or compromised is to randomise their selection. This may be seen in the selection of jury-members. Robust randomisation mechanisms are a key technique to ensuring the fidelity of data in statistical analysis and I’ve always felt it needs to be used more in public institutions as well. For example, where there are no better methods of allocating cases in a roster to particular judges (such as the known experience of the judge in the relevant field of law), case allocation could proceed through computerised randomisation. This way, there will at least not be a perception that the case allocation by a master of the roster was biased. If certainty of processes promotes agreement, the uncertainty from randomisation should discourage it.

7. Financial independence; fixed tenures: Where the potential for compromise and corruption is from another powerful entity like the government itself or rich corporations, a public institution should be insulated as best as possible from the economic incentives of better pay in other jobs and full-out bribes or disincentives such as removal from an existing job or reduction in pay. These are more ordinary no-nonsense methods of eliminating illicit economic variables from consideration in a decision-making process. Simply put, corrupt agreements are disincentivised when better incentives for compliance with law are in place. In this regard, it should also be clear why anti-corruption bodies need to be independent and well-funded.

It should appear to readers that some of these methods may appear in conflict. For example, one can’t simply keep the identity of a judge secret (in hopes of insulation from parties) and expect decisions to proceed with apparent transparency. I only seek to provide preliminary illustrations of the economic principle at play here: anti-corruption initiatives should increase the costs of corrupt agreements.


Lalit Panda is a research fellow at Vidhi Centre for Legal Policy.


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